Long term unsolicited credit rating at level AAA. The agency expects a stable outlook for the following 12 months. The rated entity was notified on October 10, 2018, about the rating and after the notification there weren’t changes or amendments in the rating. This is the first release of the rating for distribution.

The credit rating assigned to Germany stems from a strong economy and tight fiscal rule which calls for very low deficits and, thus, contributes to relatively healthy government finances and very high forward looking indicators, including governance indicators and R&D spending.

Rating components

Macroeconomic factors

Economic factors

Very high

Debt and current account factors

Very high

Public finance factors

High

Private finance factors

High

Foreign dependency factors

Very high

Liquidity factors

Very high

Final assessment

Very high

Forward-looking factors

Political and economic stability

Very high

Efficiency and reforms potential

Very high

Final assessment

Very high

Overall score

Very high

Final rating

AAA

Macroeconomic factors of rating assessment

The German economy is growing above its potential. Government finances are showing budget surpluses and declining debt and they are strong enough to tackle possible headwinds.

Economy is growing above its potential:

As an export-oriented economy, Germany is benefiting from the global increase in economic activity. In 2017, exports accounted for more than 47% of German GDP, which is 60% higher than the average of G-7 countries. Real GDP growth increased to 2.5% in 2017, the highest since 2011. Although the growth slowed somewhat in 2018, particularly due to lower exports, we expect it to remain close to 2% in 2019 and 2020. This is still above the potential growth, which is estimated at around 1.5%.

Above potential GDP growth is feeding into job markets. German companies increasingly struggle to fill job vacancies due to record low unemployment. We expect the labor force shortage to continue in the foreseeable future. The labor market integration of recently arrived refugees is slow, mainly due to skills mismatch and administrative and language barriers. Thus, it will not provide a substantial relief to the tight job market.

Scarcity in the job market has had a positive impact on wage growth. Several labor unions agreed with employers on the highest wage increase in more than a decade. This trend is very likely to spread further and should benefit private consumption, which is expected to support the economic growth in the coming quarters. In the longer run, however, the effects of negative demographics and lower potential GDP growth are expected to prevail. As a result, we expect the GDP growth to decline after 2020 to below 2%.

Public debt will decrease below Eurozone limit until 2019:

Germany has been pushing hard for fiscal consolidation in the Eurozone since the debt crisis. The fiscal rule, which took full effect in 2016 at the government level, calls for a structural deficit of no more than 0.35% of GDP. The states will have to achieve structurally balanced budgets starting from 2020.

As a result, Germany managed to achieve moderate fiscal surpluses. In 2017, the surplus was 1.3% GDP, the highest since reunification. It is expected to remain at similar level this year. Fiscal surpluses are lowering the debt burden. We expect the debt to GDP ratio to fall below 60% in 2019. In that case, Germany would be in compliance with the Eurozone fiscal rules.

General government debt (% of GDP) and Eurozone debt limit

Source: Eurostat, ERA

Tight government finance hinders investment:

German fiscal consolidation had negative impact on investment. The investment to GDP ratio in Germany is weak. It has been below 20% since 2011. In 2017, it stood at 19.7%. It is well below the savings to GDP ratio of more than 27%. One of the reasons is low government investment spending. In 2017, government investments stood at 2.1% GDP, according to OECD. It is the second-lowest among G7 countries, only slightly higher than in cash-strapped Italy.

The expected decline in the debt to GDP ratio below the 60% Eurozone limit opens up room for an increase in government investment and, thus, for reducing the investment deficit accumulated during the last years. Better physical and digital infrastructure might, in turn, increase the potential for future GDP growth. Another source for higher infrastructure growth is the business sector. High capacity utilization rates should, in theory, encourage investments in labor-saving technology.

High current account surpluses are expected to persist:

The current account surplus remains extremely high for an economy of Germany's size. We estimate the surplus to remain close to 8% of GDP this year and to decline below 7.5 % until 2020 as a result of an expected increase in domestic demand due to somewhat higher wage investment growth. We expect, however, that high current account surpluses will continue in the medium term. The fundamental reason for these surpluses, which is the impossibility of exchange rate appreciation against the rest of the Eurozone, is not going to disappear.

Current account balance (% GDP)

Source: IMF, ERA

Low risk in medium term:

Risks to the German economy in medium term are low in our view. The main risk factor, threat of tariffs on US car imports, is expected to lower the economic growth only by 0.1-0.2 percentage points. The government has, however, enough fiscal room to mitigate the possible negative impact on growth.

Beside very good fiscal health, the there are several other positive factors in play: a strong, large, and well diversified economy, relatively low private sector debt levels, high current account surpluses and also the support from the European central bank in form of ample liquidity for banks and conditional guarantee of government debt.

One source of potential problems is the political and economic stability in the Eurozone. Currently, the main risk factor is Italy, where the new populist government wants to put an end to fiscal consolidation. This might lead to a decrease in its debt sustainability. We estimate that the proposed Italian deficits should lead only to a small increase in the Italian debt to GDP ratio. Thus, the risk is not substantial in the short term.

Forward-looking factors of rating assessment

Germany has very high R&D spending and governance indicators. Political stability decreased somewhat in the recent years

High R&D spending:

Germany is the third biggest spender on R&D in the European Union. In 2016, R&D expenditures accounted for 2.94% of GDP. This figure is likely to rise even more in the foreseeable future as investment in education, research, and innovation is one the key priorities of the new coalition government. Therefore, the economy has high innovative potential, which is a positive factor for potential GDP growth in the future.

Very high governance indicators, but declining political stability and absence of violence:

Germans have very high trust in institutions. This is illustrated also by very high scores in the World Governance Indicators released by the World Bank. The political stability and absence of violence/terrorism indicator is, however, declining. In 2017, it was the lowest since at least 1996 (when the World Bank started releasing the indicator). The main reason is the increase in violent crimes in the recent years. The migration crisis together with the increase in violence fuels anti-establishment populism, which might lead to a decrease in governance indicators in the future. However, despite the decline, the political stability and absence of violence/terrorism indicator is still well above average on the global scale.

Selected World Governance Indicators (ERA score, 1-10):

Source: World Bank, ERA

Outlook: Stable

The outlook has been assigned based on expectations of continued government adherence to the fiscal rule and political stability in the Eurozone.The Stable outlook assumes that the rating will most likely stay unchanged within the 12-month horizon

Appendix 3. List of material data sources

International Monetary Fund

World Bank

Bank for International Settlements

Eurostat

OECD

Deutsche Bundesbank

Regulatory disclosure

The unsolicited credit rating and outlook were issued in accordance with ERA methodology for sovereign entities in the version from July 4, 2018 (available at www.euroratings.co.uk, section Methodology). In the same section, there is a rating scale, including an explanation of the importance of each rating category, and a default definition. Information on the rate of historical failure is available at www.cerep.esma.europa.eu, and the explanatory statement of the meaning of those default rates is available at www.euroratings.co.uk (Regulatory Framework/Disclosure). This rating is issued as an unsolicited rating, i.e., was not initiated by the rated entity or a related third party. The rated entity did not participate in the rating process and the information and documentation for its development were obtained from publicly available sources in accordance with ERA methodology. ERA did not have access to the rated entity’s internal documents. ERA, in the context of routine care, verified all sources entering the rating process. ERA considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. No actual or potential conflicts of interest have arisen. Since July 30, 2012, ERA has been a registered credit rating agency according to the of Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009 on credit rating agencies.